THE MERGERS AND ACQUISITION
MARKET. AN OVERVIEW.
INTRODUCTION TO COMPANY’S VALUE AND VALUATION
TECHNIQUES.
DCF AND COMPARABLES
Lesson 12
Corporate Finance
24th
Castellanza,
November, 2010
2
Business valuation: definition of value
 Market value: is a general estimate of what a business would
sell for in the open market. It is independent of a particular
investor
 Investment value: is the value of the business to a specific
investor. It would reflect synergies, a tax rate specific to the
investor, and policies the investor is likely to implement
 Fair value: is used in certain legal cases and the method is
defined by statute
3
How to realize an acquisition
 Analysis and definition of the industry and the target co.
 General screening of the co.s
 Specific analysis of the most interesting co.s
 Priority in contacts
 Way of contacting
 First approach
4
Methods
 Assets
 Revenues
 Comparables
Market approach
 Discounted Cash Flow (DCF)
Analytical approach
Each approach has advantages and disadvantages
Generally there is no right answer to a valuation problem.
More an art than a science!
5
Comparables (Multiples)
 Multiple = Enterprise value / most important element to value
(EBIT, EBITDA, Sales)
 Compute the average of the multiple of the companies of the
sample
 Multiply the average multiple obtained for EBIT, EBITDA or
Sales of your company
6
Discounted Cash Flow (DCF)
DCF capitalizes the cash flows the firm is expected to generate
Strenght: reflects actual benefits that investors care about
better than other methods
Weakness: relies heavily on projections. Valuations are only as
good as these projections
7
Discounted Cash Flow (DCF) (cont’d)
n
Wf = 
t=1
Ft
(1 + k)t
W
company’s value
Ft
Cash Flows
k
discount rate
n
number of periods considered
TV
terminal value of the company
+ TV
8
Cash Flows
Cash Flows to Firm
Cash Flows
Cash Flows to Equity
9
Cash Flows to Firm
The FCF are the expected cashflows to the firm, i.e., the residual
cashflows after meeting all operating expenses and taxes, but
prior to debt payments, discounted at the WACC.
EBIT
-/+ Change in Net Working Capital
+ Depreciation, amortization
- Investments
+ Divestments
- Taxes
Free Cash Flow to Firm
10
Cash Flows to Equity
The CF to Equity are the expected cashflows, i.e., the residual cashflows
after meeting operating expenses, tax obligations and interest and
principal debt payments and reinvestments needs, at the cost of equity
(ke), i.e., the rate of return required by equity investors in the firm.
EBIT
+/- Change in Net Working Capital
+
Depreciation, amortization
-
Investments
+
Divestments
-
Interests Expenses
-
Principal payments
-
Taxes
Free Cash Flows to Equity
11
Terminal value
TV =
Fn / (k-g)
(1 + k)n+1
Because businesses are typically long-lived assets and
detailed cashflows forecasts beyond 5 yrs tend to be more
fiction than fact, most analysts project cashflows for a
finite period and then assume some normal terminal value
at the end of that period
g = sustainable growth rate (usually: long-term expected
rate of inflation)
12
Business Case 1 - Valuations
How time can be critical
Overview
1° case – original business plan
2° case – revised business plan
Conclusion
13
Business Case 1
 Alpha company operates in the Italian real estate sector.
 The following tables shows the flows deriving from the
company business plan, as follow:
1
2
original business plan before the market drop (2007)
revised business plan to show the expected flows after
the crisis (2008)
To suit the new scenario, the revised business plan
postpones the expected in-flows until 6 months
14
Business Case 1
 1° case – original business plan Projections
€ million
Project 1
Project 2
Project 3
Project 4
Project 5
Project 6
Other revenues
In - flows
Project 1
Project 2
Project 3
Project 4
Project 5
Project 6
Marketing costs
Other costs
Out - flows
FCFO
untill 2006
2007
2008
2009
2010
2011
2012
2013
Totale
27,0
15,2
0,6
42,8
(58,6)
(52,0)
(1,8)
(14,4)
(5,4)
(15,2)
(0,3)
(147,7)
(104,9)
25,0
7,1
32,1
(0,1)
(0,7)
(1,2)
(0,8)
(0,3)
(3,1)
29,0
24,3
4,5
7,6
36,4
(12,7)
(3,5)
(0,5)
(16,7)
19,7
104,1
0,3
5,3
6,0
1,5
117,3
(55,5)
(0,6)
(8,9)
(0,9)
(0,2)
(66,2)
51,1
109,9
3,8
33,9
3,5
151,0
(57,6)
(2,8)
(23,6)
(0,2)
(84,1)
66,9
60,3
4,3
23,5
88,1
(38,1)
(1,6)
(10,2)
(0,1)
(50,0)
38,1
12,8
0,6
1,3
14,6
(16,4)
(0,6)
(2,6)
(19,6)
(5,0)
(7,1)
(0,3)
(2,5)
(10,0)
(10,0)
311,3
52,0
9,0
64,0
14,0
15,2
16,8
482,3
(246,0)
(52,0)
(7,8)
(62,8)
(11,1)
(15,2)
(1,8)
(0,6)
(397,4)
84,9
15
Business Case 1
 2° case – revised business plan Projections 6 month postponed
€ million
Project 1
Project 2
Project 3
Project 4
Project 5
Project 6
Other revenues
In - flows
Project 1
Project 2
Project 3
Project 4
Project 5
Project 6
Marketing costs
Other costs
Out - flows
FCFO
untill 2006
2007
2008
2009
2010
2011
2012
2013
Totale
27,0
15,2
0,6
42,8
(58,6)
(52,0)
(1,8)
(14,4)
(5,4)
(15,2)
(0,3)
(147,7)
(104,9)
25,0
7,1
32,1
(0,1)
(0,7)
(1,2)
(0,8)
(0,3)
(3,1)
29,0
24,3
4,5
7,6
36,4
(12,7)
(3,5)
(0,5)
(16,7)
19,7
43,3
0,6
3,0
1,5
48,5
(55,5)
(0,6)
(8,9)
(0,9)
(0,2)
(66,2)
(17,7)
117,0
1,6
6,5
17,8
142,9
(57,6)
(2,8)
(23,6)
(0,2)
(84,1)
58,8
88,1
5,5
36,7
130,3
(38,1)
(1,6)
(10,2)
(0,1)
(50,0)
80,3
35,0
2,0
8,8
45,7
(16,4)
(0,6)
(2,6)
(19,6)
26,1
3,7
3,7
(7,1)
(0,3)
(2,5)
(10,0)
(6,3)
311,3
61,0
6,5
0,6
7,5
78,6
16,8
482,3
(246,0)
(52,0)
(7,8)
(62,8)
(11,1)
(15,2)
(1,8)
(0,6)
(397,4)
84,9
16
Business Case 1
 Conclusion
1° case – original business plan
€ million
In - flow
Out - flow
Margin
Tax
Unlevered FCF
Years
Discount factor
Disconted cash flow
#
2009
117,3
(66,2)
51,1
(16,1)
35,1
1
0,94
33,0
2010
151,0
(84,1)
66,9
(21,0)
45,9
2
0,88
40,6
2011
88,1
(50,0)
38,1
(12,0)
26,1
3
0,83
21,7
2012
14,6
(19,6)
(5,0)
(5,0)
4
0,78
(3,9)
2013
(10,0)
(10,0)
(10,0)
5
0,74
(7,3)
2011
130,3
(50,0)
80,3
(25,2)
55,1
3
0,83
45,8
2012
45,7
(19,6)
26,1
(8,2)
17,9
4
0,78
14,0
2013
3,7
(10,0)
(6,3)
(6,3)
5
0,74
(4,6)
Valuation
Enterprise Value
84,1
NFP (giu-08)
(59,5)
Equity value
24,6
2° case – revised business plan
€ million
In - flow
Out - flow
Margin
Tax
Unlevered FCF
Years
Discount factor
Disconted cash flow
#
2009
48,5
(66,2)
(17,7)
(17,7)
1
0,94
(16,6)
2010
142,9
(84,1)
58,8
(18,5)
40,3
2
0,88
35,7
The equity value drops by 41%
Valuation
Enterprise Value
74,2
NFP (giu-08)
(59,5)
Equity value
14,7
17
Business Case 2 - Valuations
Exchange ratios in a merger
Overview
The project
Conclusion
18
Business Case 2
Overwiev
Both the Companies operates in the same sector
Company A
Company B
Capital stock
37.000
32.000.000 (€/000)
Shares
37.000
32.000
Face share value
1 (€/000)
1 (€/000)
Revenues
249.592 (€/000)
162.340 (€/000)
(€/000)
 We are going to analyse a project of merger between Company
A and Company B.
19
Business Case 2
The Project
 The merger process is supposed to be structured on a
valuation process based on general criteria of rationality,
demonstrability, objectivity and stability.
 Method’s choice: on the basis of the business’ nature and
investment plans the Unlevered Discounted Cash Flow method
has been adopted.
 Value’s determination: according to UDCF method, the
consultant has considered it right to identify, instead of a
precise value, a range of values of the share conversion ratio.
20
Business Case 2
A sensitivity analisys has been made on the basis of different
assumptions, i.e.:
-the potential companies’ prospecitve capacity to generate benefits in
terms of NOPLAT (Net Operating Profit Less Adjusted Taxes);
-different debt ratios related to WACC (Weighted Average Cost of
Capital).
Company A (€/000)
NOPLAT
7.8
7.8
5.9
5.9
6.1%
5.7%
6.1%
5.7%
Firm Market Value
82
91
59
66
Number of shares
37
37
37
37
Value of shares
2,2
2,4
1,6
1,7
5.1
5.1
4.1
4.1
6.7%
5.7%
6.7%
5.7%
Firm Market Value
73
86
62
73
Number of shares
32
32
32
32
Number of shares
2,2
2,7
1,9
2,2
WACC
Company B (€/000)
NOPLAT
WACC
21
Business Case 2
Conclusion
 On the basis of the valuation process with the UDCF method
the share conversion ratio was supposed to be in the sequent
range:
Conversion ratio
0.98
0.91
0.82
0.78
 A market approach method (market multiples method) has
furthermore been adopted to validate the share conversion
ratio:
Conversion ratio
0.80
0.78
0.77
0.76
22
Business Case 2
 Pursuant to the camparison between the different methods of
valuation the board of directors suggested to consider a share
conversion ratio between a minimum of 0.80 and a maximum of
0.85.
0.98
0.91
0.82
0.78
0.77
0.78
0.76
Flow approach: Unlevered Discounted Cash Flow
Market approach: Multiples
0.80